Trump's done a U-turn on China's currency - and he's chuffed to bits

After spending the past several years attacking China for manipulating its currency, the Trump administration is now chuffed that it has struck a deal with China under which it has agreed to manipulate its currency.

Donald Trump has now forced China to manipulate its currency.Credit:Bloomberg

While the administration provided no detail on the currency agreement, Treasury Secretary Steve Mnuchin described it as "one of the strongest agreements ever on currency".

Trump and Mnuchin have consistently accused China of being a currency manipulator even though Mnuchin’s own department concluded last year that China was not manipulating the renminbi.

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Their more recent concern, heightened when the renminbi fell against the dollar last year, was that China would devalue its currency to offset the impact of the Trump tariffs, rendering them and the leverage they provide in the trade negotiations ineffective.

Where, a decade ago, China did deliberately depress its exchange rate as part of its then-mercantilist policies, in recent years it has pursued a stable and stronger renminbi as its economic policies have swung away from export-led growth to consumption and the cautious opening up of its economy to external capital.

To the extent it has intervened in currency markets it has been to prop up the renminbi, not to devalue it.

Indeed, when the exchange rate against the US dollar was creeping up towards seven renminbi to the dollar, its authorities intervened. Since the start of November last year the renminbi has appreciated by more than 4 per cent against the dollar.

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There were good reasons for the depreciation of the renminbi last year.

The Trump tariffs were obviously a major negative for a Chinese economy that was already slowing and which contains excess capacity and destabilising financial leverage and imbalances. Moreover, the US economy was growing strongly and US interest rates were rising, pushing the value of the US dollar up against all major currencies.

The renminbi should have been depreciating even more significantly.

Apart from a desire to avoid inciting Trump and his China hawks any further, China has had its own reasons for wanting to maintain a stable currency and err on the side of a stronger rather than weaker currency.

In 2015, in the midst of its crackdown on corruption and with the renminbi starting to depreciate quite rapidly, China experienced massive outflows of capital. To stem the flight of capital it used up the best part of $US1 trillion – about a quarter – of its international reserves.

Given the vulnerability of its over-leveraged economy today, it wouldn’t want a repeat of that episode. Its economic policies, which involve opening up more of its economy to market influences and shifting the emphasis from investment to consumption, would be undermined by significant depreciation.

Thus, for the moment at least, it suits China to defer to the US demands for it to maintain an exchange rate against the dollar that is higher than it would be if market forces were left unchecked - to manipulate its currency in the opposite direction to the one the US has traditionally accused it of doing.

In the longer term, whether falling into line with the US demands is a sensible decision is questionable.

In effect, even as the trends within the two economies are diverging, China has agreed to peg its currency to the greenback and essentially import US monetary policy.

Janet Yellen, former chair of the US Federal Reserve, says Donald Trump doesn't have a basic grasp of economics.Credit:Bloomberg

If the US maintains superior economic growth to the other developed economies and higher interest rates, the renminbi will strengthen against the currencies of all its major trading partners, not just the US.

That would restrict its ability to respond to conditions within its own economy, either via depreciation or by lowering interest rates.

If the agreement, along with whatever else the Trump administration can coerce the Chinese into conceding, were to weaken already-slowing Chinese growth, that wouldn’t be good news for the world economy or the US.

The trade conflict the US ignited with China is based on a similar foundation of mistruths and misunderstandings to Trump’s accusations that China is a currency manipulator.

China’s trade surplus with the US peaked at almost 10 per cent of GDP more than a decade ago and has been steadily shrinking to the point where today it is around 1.3 per cent of GDP today. Even that presupposes that US trade deficits actually matter, which they don’t.

As former Federal Reserve board chair, Janet Yellen, said overnight, Trump doesn’t have a grasp of basic macro-economics. The same could be said of his economic and trade advisers.

They are embroiled in a conflict that will damage China, the US and the rest of the world economy; one predicated on views of the Chinese, US and global economies that might have been reasonable a decade and a half ago but are anachronistic and destructive today.

Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.